EUR 850.00 For Business Accounts Only

Morningstar | As Expected, Covia Reports Weak 4Q Owing to Downturn in Frac Sand Demand

As expected, Covia reported weak fourth-quarter results. Revenue was down 16% sequentially, and adjusted operating margin slipped to negative 6% from 1% in the prior quarter, both mostly due to the energy segment, which was affected by the downturn in frac sand demand. Our fair value estimate and no-moat rating are unchanged for now.

Energy segment revenue fell 21% on a 3% decrease in volumes and a decrease in average selling price to $59 per ton from $72 previously, reflecting weaker like-for-like pricing and a mix shift to lower-priced mine-gate sales. The volume decrease was more modest than industry levels owing to Covia's startup of low-cost in-basin mines.

The bottleneck in Permian Basin takeaway capacity has caused a slowdown in U.S. shale completion activity and therefore reduced the demand for frac sand. This completion slowdown accelerated in the fourth quarter, and we think industry frac sand demand declined about 20% sequentially. However, the takeaway constraints are still set to be alleviated by the second half of 2019, meaning that these issues are largely temporary. On the other hand, the ongoing expansion of low-cost in-basin sand capacity is a permanent headwind affecting frac sand producers' pricing and utilization. In-basin sand capacity expanded throughout 2018, and we forecast that it will continue to grow in coming years.

Energy segment gross margin per ton fell to $7 per ton from $14. Covia has lagged peers U.S. Silica and Hi-Crush on this metric owing primarily to its lack of a last-mile logistics solution. However, we don't think management made a poor decision by eschewing entrance into the last-mile business, as we think competitive pressures will compress profitability in this business in the long run.